Below are the cash conversion cycles for Amazon (NASDAQ:AMZN) , Target (NYSE:TGT) and Wal-Mart (NYSE:WMT). The cash conversion cycle describes how quickly you turn over inventory, collect from your customers and pay your suppliers - in essence how efficient your operating cycle is and how quickly you convert a sale in to cash - and as a result how much working capital your business needs.
One of these is not like the others. Amazon's is negative. Amazon's operating cycle, rather than using cash, actually generates cash. Through the magic of collecting money from customers instantly via credit card and paying for them 75 days later (see my article here), Amazon has taken what is usually a use of cash (buying inventory) in to a source of cash.
Pretty Amazing. No profits, no problem. We still have 'cash flow' - and cash is king. The Amazon 10k even says ""Our financial focus is on long-term, sustainable growth in free cash flow per share"
Problem is, a negative operating cycle generates cash flow only as long as revenue growth keeps up. The reality is that a big chunk of Amazon's 'cash flow' is really just an operating cycle game. They are really just borrowing 'cash flow' from suppliers as Accounts Payable.
And that is my core issue with Amazon - the sustainability of using your Accounts Payable to fund a business. It really only works when a company is growing, and that is the reason Amazon continues to grow at any cost. Amazon has told the street to look at 'cash flow' as their performance metric, but now has themselves in a bit of conundrum. If they raise prices, growth stops or slows and 'cash flow' growth stops or slows. They are basically Dell a few years back - a negative working capital business that generates a ton of 'cash flow' when it is growing, but the instant it stops or slows it reverses and is a big problem.
But for now 'growth managers' look at it as a positive (Amazon has to grow!) rather than a negative (The growth rate is eventually unsustainable!). However, Amazon is really just the law of large numbers. The bigger you are, the harder it is to keep up that growth. That is why you see Amazon branching out in to more and more low margin businesses (groceries anyone?). I mean, have any analysts even looked to see how low the margins are in 'good' grocery businesses? But Amazon doesn't care, they just want the top line growth - it's just an operating cycle arbitrage for Amazon. Collect with credit cards instantly, pay by invoice in 75 days.
Or look at it this way. As a thought experiment, think about what would happen if you sold $100 bills for $99, but were able to buy them on credit with an invoice due in 75 days. You would sell out 10 times over before the first invoice was due. But eventually you'd run out of $100 bills to sell because the Treasury only prints so many. When you ran out you'd have to find another product to sell and generate some more 'cash flow' before the invoices were due. That is Amazon in a nut shell.
Can it continue for a few more years? Sure.
Is it sustainable in the long term? Absolutely not.
Although none of this really matters, because for now, that is why Amazon gets a "Free Pass" from fund managers. The operating cycle continues to generate cash even when it doesn't generate profits - as long as the topline is growing. Because Amazon MUST grow the topline or the charade is over, nobody sells. It can continue growing for sometime before it eventually hits the growth wall, but it will happen eventually. It's really just a matter of time. And now that the price has gotten so disconnected from reality, it could be sooner rather than later.
Additional disclosure: I am long puts and calls in Amazon.